During the Bush administration a number of significant reductions in revenue were enacted, especially in the 2001 and 2003 tax bills, but with a sunsetting provision that (extended in some cases) generally will mean that the pre-existing provision will be reinstated after 2010. Both individual and corporate taxes were reduced. Many of the corporate and business provisions involved accelerated expensing provisions, allowing businesses to write off purchases much faster than the economic depreciation of the asset would require and thus amount to a significant tax reduction for businesses. Rates on capital gains were reduced, and dividends, which have traditionally been treated just like interest income and taxable at ordinary rates to individuals, were temporarily made subject to the preferential capital gains rates. The estate tax was phased down and then completely eliminated for the 2010 tax year. As a result of these and other changes, capital income is especially favored under the temporary provisions, and the wealthiest 1% who own a substantial portion of the financial assets received significant benefits.
Much of the argument in favor of reducing taxation on the income from capital is spurious. It is a claim that by taxing returns from capital less heavily than returns from labor, those who receive those returns will invest them in new businesses, spurring entrepreneurship. The returns from capital that are favored, however, are not closely correlated with reinvestments in businesses. Most of the returns are those gained merely from secondary market trading and those increases in capital do not go to businesses but to other investors or financial institutions. There is a special provision that taxes initial issuance corporate stock gains more favorably, but that is only a small piece of the capital gains preference.
In terms of the economy, it is highly likely that tax cuts for lower income taxpayers will be spent domestically and thus provide important impetus to economic growth at this point in the recession. Tax cuts for the wealthy and owners of financial assets at the top of the distribution are much less likely to spur economic development--the wealthy are well known for utilizing tax shelters (legitimate and not so legitimate) and for moving assets offshore into tax haven jurisdictions (sometimes through illegitimate use of foreign banking secrecy laws to evade US taxation). The wealthy may reinvest their gains in new businesses (or private equity funds that spend some part of their accumulated assets in funding new businesses), but they are also likely to invest much of those gains abroad or to put them into the shadow banking system, which played a role in the financial crisis (that developed into a full blown recession) by creating a huge amount of leverage and interconnectedness.
Those with considerable amounts of financial assets also tend to be the ones who make possible the riskier types of investments. Yes, we want some adventuresomeness, but the appetite for risk and high returns that led to the financial crisis and recession was problematically high. Higher taxes on capital income would tend to temper that appetite for risk.
Further, concentrations of wealth create problems for democratic societies, especially at a time when at least 8 million Americans find themselves out of work and many out of their homes at the same time. Wealth concentrations lead to gated communities and the isolation of the wealthy from the mainstream of society. The ability to understand problems and to understand the distribution of benefits and burdens diminishes. When there is a group of people so well off that they are simply not "in the same boat" as everybody else, society is negatively impacted. Tax policy cannot cure the problem, but it can address it and ameliorate the worst of the consequences of concentrated wealth accumulation.
These are concepts that Congress should bear in mind as it considers whether or not to enact new tax cuts that will extend the Bush tax cuts longer.
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